The Markets August 15, 2019

Despite the Volatility, Market Experts Shy Away From Predicting Recession

Brexit uncertainty. An inverted yield curve. A burgeoning trade dispute between the U.S. and China. Slowing global growth and shifting currency valuations. Is it all enough to spark a recession?

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Speaking with PLANADVISER during what has proven to be something of a wild week for the U.S. and global equity markets, investment experts reiterated their perspectives that a recession is not very likely in the near term.

The recession risk is higher now with the trade issues, they note, and the fact that corporate profits are slowing down, but a recession is generally not in most economists’ base case. When it comes to interest rates in the U.S. and what influence the Federal Reserve’s recent rate cut may have had on equity markets here and abroad, most say the 25 basis point cut was to be expected.

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Still the market reaction to the rate cut was still significant. Some speculate that President Trump tweeting about his feelings that a bigger rate cut is needed caused some of the market jitters. The markets have also seemingly reacted to the president’s heated tweets the yield curve.

Yield Curves and Recessions

Christopher Hyzy, chief investment officer at Merrill, a Bank of America company, suggests the current yield curve inversion—often called a harbinger of recession—is due more to declining inflation expectations and growth expectations, and the weight of negative bond yields in Europe.

“If the Fed begins an easing campaign, the short end should begin to turn downward, changing the shape of the overall curve,” he says. Longer-term bonds typically offer higher returns, or yields, to investors than shorter-term bonds. The yield curve inverts when yields on that shorter-term debt exceeds those on longer maturity debt.

Hyzy adds that some market watchers believe the U.S. is the late stages of the business cycle with a rising probability of a recession. However, he says, Merrill believes there have actually been a series of “mini wave” pullbacks that have made a significant recession less likely. 

“We are in the early to mid-stages of the fourth mini wave since the Great Recession,” Hyzy suggests. “Our view is largely based on current economic conditions, many of which are not typical of a cycle’s late stages historically.”

Remember the Economic Outlook

Offering some additional context for the recent market volatility, the Natixis Midyear Strategist Survey suggests outcomes for 2019 will be “more muted as markets grapple with a number of downside scenarios and little in the way of upside surprises.”

According to the survey, a “messy Brexit outcome” is the most likely downside risk, while a rebound in growth driven by new central bank policy ranks as the most likely upside. The survey also identifies a more bullish outlook for U.S. sovereign bonds, emerging market equities, global real estate investment trusts (REITs) and emerging market bonds due to accommodative central bank policy.

“The survey results clearly show that, in aggregate, our respondents don’t see a lot of positive market catalysts on the horizon—nor do they see a recessionary worst-case scenario as very likely in the near term,” says Esty Dwek, head of global market strategy, dynamic solutions, Natixis Investment Managers. “It’s a kind of a ‘muddle through’ outlook.”

Natixis strategists predict little in the way of equity returns in the U.S. and Eurozone over the next six to twelve months. But that’s not to say the consensus calls for dramatic losses either. Overall, according to the survey, the outlook on equities is balanced and no strategists forecast a bear market (-20%) or even a market correction (-10%) in this time frame. On average, the strategists predict the U.S. Fed will ease rates back by 50 basis points by year-end. In Europe, respondents see further easing from the European Central Bank (ECB) and anticipate a 5 bps to 10 bps reduction in the overnight deposit rate.

The Natixis strategist projections for volatility go hand-in-hand with the equity outlook, anticipating a slight increase in volatility, “with the VIX rising 2.1 points from its mid-year level of 15.1.” This average projection to 17.2 represents “a modest but meaningful increase in volatility overall.” The VIX is the Cboe Options Exchange Volatility Index.

Compliance August 14, 2019

ERISA Complaint Questions Alternatives Use in Custom TDF

Retirement plan fiduciaries at Intel are accused of exposing investors to bets on speculative areas of the markets.

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As it awaits the results of a Supreme Court appeal on another case scrutinizing its investment decisions, Intel Corporation now faces an additional lawsuit questioning the fees and performance of custom target-date funds (TDFs) offered to its defined contribution (DC) retirement plan participants.

The lawsuit, filed in the U.S. District Court for the Northern District of California, suggests a number of Intel defendants breached their fiduciary duties by investing billions of dollars of employees’ retirement savings in “unproven and unprecedented investment allocation strategies featuring high-priced, low-performing illiquid and opaque hedge funds.”

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Case documents show the lead plaintiff is a participant in two Intel retirement plans, bringing this action on behalf of a class of similarly situated participants. According to the plaintiff, Intel plan fiduciaries “deviated greatly from prevailing professional investment standards for such retirement strategies in several critical ways.” Chief among them, according to the lawsuit, is the investing of billions of dollars in hedge funds, private equity and commodities.

“And then, as investment returns repeatedly lagged peers and benchmarks, [plan fiduciaries] did nothing while billions of dollars in retirement savings were lost,” the complaint states. “[Defendants] deviated from the standard of care of similarly situated plan fiduciaries who select target-date funds for their plans that include little or no exposure to these strategies.”

The complaint further states that Intel defendants failed to properly monitor the performance and fees of either the custom TDFs or of a custom multi-asset portfolio with a fixed allocation model that is also available to participants. The complaint says defendants failed to properly investigate the availability of lower-cost investment alternatives with similar or superior performance and failed to properly monitor and evaluate the “unconventional, high-risk allocation models adopted for these custom investment options.”

Additionally, the compliant states, Intel defendants failed to provide adequate disclosures associated with the custom investment options’ “heavy allocation” to hedge funds and private equity, and either misinformed or failed to inform participants about the allocation mix of their account balances and the allocation strategy of the custom options.

“As a result of these imprudent decisions and inadequate processes, defendants caused the plans and many participants in the plans to suffer substantial losses in retirement savings,” the complaint alleges.

Stretching over 100 pages, the complaint includes substantial detail about the process Intel allegedly used to create and manage the custom funds. Notably, until January 1, 2018, the Intel TDFs and multi-asset funds were not technically funds—as there was no distinct legal entity such as a mutual fund or collective trust that held the investments. Rather, they were allocation models that directed participant savings into various pooled investment funds. Each of these pooled investment funds was structured as a collective trust. Effective December 31, 2017, the Intel models were converted to standalone collective investment trusts.

According to plaintiffs, throughout the history of these investment strategies being offered, participants have consistently been charged fees significantly higher than both actively managed and passively managed target-date series offered by professional asset managers. At the same time, plaintiffs allege, the custom investments have demonstrated substantially worse performance, both in absolute terms and on a risk-adjusted basis.

Readers may be aware this is in fact at least the second lawsuit Intel faces questioning its decisions in offering custom investments. Back in November 2015, plaintiffs first filed what has now proved to be a long-running compliant that similarly alleges fiduciary failures by various Intel defendants. That case, Sulyma v. Intel Corporation, was initially decided in favor of Intel on statute of limitations grounds. However, the 9th U.S. Circuit Court of Appeals overturned the ruling in December 2018, finding that disputes of material fact exist as to the timing of the plaintiff’s actual knowledge of the alleged fiduciary breach, precluding summary judgment for untimely filing. This appellate ruling in turn has been accepted for review in the next term of the U.S. Supreme Court.

The Sulyma case is potentially quite significant in that the question of what creates “actual knowledge” plays directly into arguments of timeliness under ERISA. In basic terms, this is because the timing of when “actual knowledge” of a potential fiduciary breach is established is used to define when one of several potential statues of limitations will start to run for a given fiduciary action or decision.

The full text of the new complaint is available here. 

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